Contingencies

probability, eventuality, predicament

A contingency is a future event or circumstance that is possible but cannot be predicted with certainty.

Contingency is a potential negative event which may occur in the future such as a natural disaster, fraudulent activity such as financial crime or a terrorist attack. In finance, managers often attempt to identify and plan for any contingencies that they feel may occur with any significant likelihood. To mitigate risk, financial managers often err on the conservative side, assuming slightly worse-than-expected outcomes, and arranging a company’s affairs so that it can weather negative outcomes with the least distress possible.

To plan for contingencies, financial managers often recommend setting aside significant reserves of cash so that the company has strong liquidity, even if it meets with a period of poor sales or unexpected expenses. Managers may seek to proactively open credit lines while a company is in a strong financial position to ensure access to borrowing in less favorable times. For example, pending litigation would be considered a contingent liability. Contingency plans typically include insurance policies that cover losses that may arise during and after a negative event. Business consultants may also be hired to ensure contingency plans take a large number of possible scenarios into consideration and provide advice on how to best execute the plan.

Contingency Plan Considerations

A contingency plan needs to prepare for the loss of intellectual property through theft or destruction, so backups of critical files and computer programs as well as key company patents could be kept in a secure off-site location. Contingency plans need to prepare for the possibility of operational mishaps, theft and fraud. A company should have an emergency public relations response relating to possible events that have the ability to severely damage the company’s reputation and its ability to conduct business. How a company is reorganized after a negative event should be included in a contingency plan. It should have procedures outlining what needs to be done to return the company to normal operations and limit any further damage from the event. Financial services firm Cantor Fitzgerald was able to resume operation in just two days after being crippled by the 9/11 terrorist attacks due to having a comprehensive contingency plan in place.

Benefit of a Contingency Plan

A thorough contingency plan minimizes loss and damage caused by an unforeseen negative event. For example, a brokerage company may have a backup power generator to ensure that trades can be executed in the event of a power failure, preventing possible financial loss. A contingency plan reduces the risk of a public relations disaster. A company that effectively communicates how negative events are to be navigated and responded to is less likely to suffer reputational damage. A contingency plan often allows a company impacted by a negative event to keep operating. For example, a company may have a provision in place for possible industrial action such as a strike so obligations to customers are not compromised. Companies that have a contingency plan in place may obtain better insurance rates and credit availability as they are seen to have reduced business risks.

Contingent Liability

A contingent liability is defined as a liability which may arise depending on the outcome of a specific event. It is a possible obligation which may or may not arise depending on how a future event unfolds. A contingent liability is recorded when it can be estimated, else it should be disclosed.

A contingent liability is a liability or a potential loss that may occur in the future depending on the outcome of a specific event. Potential lawsuits, product warranties, and pending investigation are some examples of contingent liability.

If the amount can be estimated, the company sets aside that amount separately to be paid out when the liability arises. Contingent liability as a term does not apply only to companies, but to individuals as well.

Contingent Asset

A contingent asset is a potential economic benefit dependent solely on future events that can’t be controlled by the company. Due to the uncertainty of the future events, these assets are not placed on the balance sheet. However, upon meeting certain conditions, contingent assets are reported in the financial statements in the accompanying notes.

A contingent asset is also known as a potential asset because there is the potential for future benefits to the company. Contingent assets may arise due to the economic value being unknown. In addition, they may arise due to uncertainty relating to the outcome of an event in which an asset may be created. A contingent asset occurs because of previous events, but the entirety of all asset information will not be collected until future events occur.

Contingent Shares

Shares of company stock that are issued only if certain conditions are met. Contingent shares are similar to stock options, warrants and other convertible instruments in that there is a level of uncertainty associated with their issue. For example, for contingent shares to be issued, the corporation must generate earnings that exceed a certain threshold. Contingent shares are also important for common stock holders since the contingent shares can dilute the ownership of existing shareholders.

In the TARP bailout, the U.S. Treasury was granted contingent shares in certain companies. These shares were meant to offset the risk of loss for taxpayers. Under the terms of the agreement, the contingent shares vest automatically if the U.S. Treasury loses money as a result of purchasing the troubled assets.

Contingent Payment Sale

A contingent payment sales is a type of installment sale in which either the price or payment period for the asset has not been fixed. Contingent payment sales entail a special set of rules that vary according to whether the price or the schedule is the fixed amount. For example, if you sell your business and part of the price includes a share of future revenues or profits, this would be a contingent payment sale.

Because the final amounts in these transactions are uncertain, it is difficult to calculate tax liability for any capital gains. The methods for calculating tax liability for contingent payment sales transactions include determining a maximum selling price or, alternatively, determining a fixed period during which payments will be made by the buyer to the seller.

Contingent Guarantees

Contingent guarantees are a guarantee of payment made by a third party, known as the guarantor, to the seller or provider of a product or service in the event of non-payment by the buyer. Contingent guarantees are normally used when the suppliers do not have a relationship with their counterpart. The buyer pays a contingent guarantee fee to the guarantor, which is generally a large bank or financial institution.

Contingent guarantees are a common feature in international trade, especially when vendors conduct business with new customers in overseas markets. Note that a contingent guarantee differs from a letter of credit, which is more commonly used in international trade. The former only comes into effect upon non-payment after a stipulated period by the buyer, whereas a letter of credit is payable by the bank as soon as the seller effects shipment and satisfies the terms of the LC.

Contingent guarantees are also used as a risk-mitigation tool for large projects in nations with a high degree of political or regulatory risk, as well as in certain income-oriented financial instruments.

Contingent Beneficiary

A contingent beneficiary is specified by an insurance contract holder or retirement account owner as receiving proceeds if the primary beneficiary is deceased, unable to be located or refuses the inheritance at the time the proceeds are to be paid. A contingent beneficiary is entitled to insurance proceeds or retirement assets only if predetermined conditions are met at the time of the insured’s death (as can be found in a will).

Virtually any conditions may be in place for a contingent beneficiary of a will, as it depends entirely on the person drafting the will.

Contingent Commissions

A contingent commission is a commission with a value dependent on an event occurring, and paid to an intermediary by an insurance company or reinsurance company. A contingent commission may, for example, have its value based on how profitable the policyholder is to the insurer or reinsurer. Contingent commissions are higher when the insurer or reinsurer does not suffer losses from claims, and are lower when policyholders are riskier.

Contingent commissions differ from more traditional commission structures because the commission is not collected in the event that the policy is sold. The event that the compensation is contingent on may vary according to the needs of the insurer or reinsurer, and may include the profitability of the policy or the amount of business that the client brings in. This type of commission may be paid in addition to a sales commission based on the amount of premium.

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